Court holds NYDFS "best interest" rule is unconstitutionally vague

A unanimous opinion of an intermediate appellate court in Albany, dated April 29, 2021, has struck down the 2018 amendment to New York State Department of Financial Services (NYDFS) Regulation 187 – formerly known as "Suitability in Annuity Transactions."  The 2018 amendment re-titled the regulation as "Suitability and Best Interests in Life Insurance and Annuity Transactions" and significantly changed the landscape in New York by not simply imposing a "best interest" of the consumer standard in the recommendation of annuities, but by applying that same standard to the sale of life insurance.  The Appellate Division, Third Department, of the New York State Supreme Court agreed with the petitioners, who are various insurance producer organizations, that the amendment "violates [the petitioners’] due process rights as it is unconstitutionally vague."

The amendment was proposed in late 2017, at a time when the National Association of Insurance Commissioners (NAIC) considered amending its model law on the same topic.  DFS subjected the proposal to two public comment periods, made a number of revisions to the initial draft, and promulgated the final regulation as of August 1, 2018.  The changes went into effect in August 2019 for annuities transactions and six months later for life insurance. 

The amendment was, according to its preamble, designed to "clarify" insurers’ and insurance producers’ obligations in dealing with consumers.  As amended, the regulation imposed a best interest obligation on insurers and producers which required that they consider "only the interests of the consumer … in making the recommendation" to purchase or replace an existing annuity.  Moreover, the new regulation imposed the same standard of care in connection with the recommendation of a life insurance product, substantially widening the scope of the original regulation and taking a leap from the NAIC’s position.  (The NAIC ultimately adopted a best interest standard which applies only to annuity sales and replacements.) 

According to then-Superintendent Maria Vullo, the new regulation was intended to show that New York was leading the way in consumer protection.  The press release issued by DFS at the time stated that the regulation was a necessity in light of activities at the federal level.  DFS wrote:

The regulation will fill in regulatory gaps to protect New York consumers from the elimination of the federal Department of Labor’s Conflict of Interest Rule, which the Trump Administration failed to protect on appeal after a ruling from the U.S. Fifth Circuit Court of Appeals and also supplements existing consumer protections that already exist in New York, including setting reasonable limits on compensation and compensation transparency for the sale of a life insurance or annuity product in New York State.

In bringing suit in 2018, the petitioners unsuccessfully argued that the amendment violated the State Administrative Procedures Act, was arbitrary and capricious, and unconstitutionally vague.  On appeal, they renewed their arguments.  As their last point – comprising roughly three of the 25 pages in the brief – the petitioners argued that the amendment fell within New York’s version of the constitutional "void for vagueness" doctrine.  

In reversing the trial court, the panel focused exclusively on that very last point.  The Appellate Division appears to have found that the scope of what DFS defined as a recommendation, and therefore actionable conduct, was so broad as to encompass all statements by a producer.  That breadth, according to the court, meant that the language was not "'sufficiently definite so that individuals of ordinary intelligence are not forced to guess the meaning of regulatory terms.'"  Moreover, the court concluded that because DFS did not precisely define language or conduct by which a producer could definitively demonstrate that she acted in the customer’s best interest, enforcement activity under the amended regulation would give DFS "virtually unfettered discretion’ in determining whether a violation has occurred."

It is difficult to forecast what the practical impact of the decision will be in the near term.  The regulation has been in effect since mid-2019 and insurers and producers in New York have spent significant time and money on compliance efforts.  Moreover, because the decision is only days old, it remains to be seen whether DFS will pursue an appeal to the Court of Appeals; seek a stay, rehearing or some other tactic; or reconsider the approach altogether.  That uncertainty suggests that for time being the industry may be reluctant to take significant steps in this area. 

We note that the Appellate Division’s decision specifies that "Regulation No. 187, as amended, is unconstitutional,"^[1] not its predecessor, indicating that New York continues to have an in-force regulation regarding annuity suitability.^[2]  On that basis, one supposes that the NAIC’s new model, which imposes a differently worded and more narrowly applied best interest standard, could be considered for adoption by DFS.  If history is guide, that seems an unlikely outcome – although the Appellate Department’s decision probably seemed unlikely to many at one time too.